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Currency Risks: Disturbance in the Water

After two years of relative stability, the currency markets may be readying for a year of heightened volatility. Will companies be prepared?

To gauge the outlook for hedging currency risk in 2014, some recent historical perspective is in order.

The CFO blessed with perfect foresight had some reasons to pull back on hedging such risk the last two years. Knowing that the value of the U.S. dollar would be range-bound versus major world currencies, that CFO would have declared the cost of foreign-exchange volatility bearable, and the overall risk less, even if the exposure were large.

There are no CFOs with absolute knowledge of future currency movements. Still, many companies didn’t hedge currency risk. Those with invoices to pay in foreign currency, especially, seem to have taken a wait-and-see stance with U.S. dollar pairs.

A study of 1,075 companies by Chatham Financial found that 76% had forex exposure in 2012, but only 48% hedged it using financial instruments. Data from the Bank for International Settlements, meanwhile, showed, as of September, a 12%, two-year decline in forex-transaction dollar volume for nonfinancial customers. CFO’s own recent survey of 148 finance executives found that 51% of respondents don’t expect to hedge forex or commodity-price risks in 2014.

A relative lack of volatility in the value of the U.S. dollar against other currencies and the possibility of its appreciation last year turned some companies off hedging. With the Federal Reserve’s quantitative easing program expected to end, experts anticipated higher demand for the U.S. dollar from the euro and G8 countries’ currencies. The inflows didn’t rise — QE didn’t end — but more important for 2014, institutional investors’ confidence in the United States eroded because the government was seen as “destabilizing and divided,” says Guido Schulz, chief strategy officer at Associated Foreign Exchange. “Investors think that the U.S. government potentially won’t be able to react to crisis with this deadlock [in Congress].”

13Dec_Outlook_p28bOn the flip side, “the euro has really weathered anything and everything,” says Schulz — in particular, declarations that it was overvalued and renewed concerns about euro-zone members like Spain and Italy. “The U.S. dollar has not been able to capitalize on that, and the deadlock has lulled many companies into a feeling of predictability,” says Schulz.

Low and stable interest rates and relatively balanced economic growth rates across the G20 calmed foreign-exchange markets for a while, says Mark Frey, chief market strategist of Cambridge Mercantile Group, a forex and payments services company.

A Wild Ride to Come?
But the stage is very possibly set for more-erratic forex in 2014. Part of the reason: national monetary policies and interest rates of the major developed economies are diverging. While the U.S. economy has yet to pick up a full head of steam, it could gain momentum next year, pushing the Federal Reserve into altering monetary policy and pulling back on QE. “We do expect we will see interest rates, from a monetary-policy and a market-determined perspective, creep back up, and that has implications,” Frey says.

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